Getting Lost on the Road to Recovery Why We Need More Keynes and Less Caricature

Rowe, Jason, Kennedy School Review

After a descent not seen since the Great Depression, the U.S. economy is finally starting to tangibly recover. The turnaround is due in large part to the American Recovery and Reinvestment Act (ARRA), the Keynesian fiscal stimulus enacted by Congress and signed into law during the first weeks of the Obama administration. The stimulus quickly halted the economy's two-year hemorrhaging of about 9 million jobs and helped reactivate the engines of job creation (Bureau of Labor Statistics 2012a). Yet recovery has been slow, as the depth of the recession and the degree of needed countervailing stimulus both proved greater than most analysts had initially forecast.

While ARRA produced some incremental gains, accelerating the recovery will require a more vigorous Keynesian boost. Instead, Congress has largely abandoned Keynesian fiscal policies. To borrow a metaphor from Jeffrey Liebman, a professor at the Harvard Kennedy School and adviser in the early Obama administration, Congress's incoherence is akin to confused firefighters facing a large house fire. The firefighters exhaust their water supply after successfully fighting back but before extinguishing the blaze. They then conclude that water does not extinguish fires, leave the still burning house, and head back to the fire station. Partisan politics has driven many in Congress to make similar pronouncements on the efficacy of long-proven Keynesian policies.

Worse yet, Congressional leaders have redirected the urgency of the unemployment crisis to distracting concerns about federal debt. Their recent pursuit of fiscal austerity threatens to exacerbate rather than expedite the sluggish pace of recovery. If the jobless are not to be left to languish, policy makers will have to return to sensible economics and provide another urgently needed dose of Keynesian fiscal action.

DRIVING 25 ON THE FREEWAY

Current economic conditions, while improving, are still bleak. The economy created about 3 million total jobs in 2010 and 2011. However, that still leaves a yawning gap of more than 10 million jobs in order to restore prerecession levels, when accounting for the 9 million jobs directly lost to the Great Recession and the fact that a healthy economy would have created at least 100,000 jobs per month merely to keep up with labor force growth. At the last two years' average pace of 1.5 million new jobs per annum, it would take more than three decades to fill this gap (Bureau of Labor Statistics 2012a). Meanwhile, a historically unprecedented share of the unemployed--nearly half--is going without jobs for longer than twenty-seven weeks (Bureau of Labor Statistics 2012b). Such enduring unemployment brings not only economic desperation but also long-term scarring of the labor force as workers lose skills and start taking positions for which they are not a good fit.

While fiscal policy makers have decided to do nothing to stabilize the economy for the last three years, the Federal Reserve has actively tried to pick up the slack. Yet the slack is too great for the Fed to handle alone, and without support from Congress, it has exhausted its available policy levers. The Fed's primary mechanism for responding to recessions is to lower the Fed Funds rate, or the interest rate levied on banks, in order to decrease the cost of borrowing and spark investment. In late 2008, the Fed lowered the Fed Funds rate to essentially zero, where it has since remained (Board of Governors of the Federal Reserve System 2012). But since interest rates simply cannot be reduced below zero, there is little more a central bank can do once the rate is set to zero. While the Fed has continued to engage in extraordinary policy measures--multiple rounds of quantitative easing and 2011's "Operation Twist"--as a way to try to overcome the limitations created by this zero lower bound, the hands of monetary policy makers are largely tied. Further action will have to come from Congress. …

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